Credit limit proposed as safeguard against housing recession

Tightening credit and boosting interest rates on mortgages may insulate the economy from another recession, two finance experts argued Wednesday, challenging political pressure that home ownership should be encouraged by relaxing credit terms.

Amir Sufi, an economist at the University of Chicago Booth School of Business, explained that economic downturns, ranging from the Great Depression to the 2008 Great Recession, are typically preceded by a spike in personal debt levels.

Economist Benjamin Keys agreed. The University of Chicago public policy professor said that in the pre-recession real estate boom speculative lenders bet housing prices would continue to rise and offered a slew of atypical mortgage products. He cited the 40-year and partial-interest-payment-only mortgages as examples of the now banned lending practices that became popular in the last decade. The deceptively cheap mortgages with artificially low starting payments were often offered to customers who were unable to pay them off.

These risky products were "not tracked at all by regulators," Keys said.

When the economy tanks, borrowers still owe their creditors, putting a disproportionate concentration of risk on those who can least afford it, Sufi said.

“How far can you impose losses on debtors?” Sufi asked at the Kreisman Housing Breakfast Series’ The Future of Housing Finance: Lessons from the Housing Crisis, at the University of Chicago's Gleacher Center in downtown Chicago.

Sufi said credit plays a greater role in average households than in those of top earners, magnifying the impact of an economic downturn on everyday consumers. Lower-income homeowners’ wealth was largely wiped out when housing prices collapsed in 2008. As a result, consumers reeled in their spending, which stunted economic growth.

“If Bill Gates loses $35,000, it isn’t changing his spending, but if a household only has $35,000, they’re cutting back,” Sufi added.

Sufi proposed a more even distribution of losses between lenders and debtors to soften the blow when the economy thuds, but not everyone accepted the economist’s prescription.

“It’s politically naive,” said housing attorney John Ahearn, who attended the session. “The sharing of equity is from the rich people to the government." He was concerned Sufi’s proposed risk redistribution wouldn’t reach the borrowers who need it, arguing mortgage sellers would find ways around new rules.

“Regulation just creates new opportunities,” he said.

But regulations are underway, with the Consumer Financial Protection Buerau’s “qualified mortgage” rules that became effective this January, and current Senate debate over the Johnson-Crapo bill, which proposes to replace mortgage-buying entities Fannie Mae and Freddie Mac with a new agency, the Federal Mortgage Insurance Corp.

The Consumer Financial Protection Bureau requires creditors to take a critical look at consumers’ ability to repay any consumer credit transaction secured by a dwelling.

Whether such policies will be effective safeguards against over-leveraging and another financial downturn is yet to be seen.

Sufi’s tighter-credit policy would affirm today's dried-up mortgage market. The American dream shouldn’t be hitched to home ownership, he said. Consumers should rent their homes, rather than take out massive debt loads, even though that means foregoing a buildup of equity, a form of saving.

“But the thing is, saving is not in the American DNA,” said Lara Moynihan, owner of Camillpo Properties Ltd., a housing developer and manager. “The economy is dependent on it; if people started saving, we would go into another recession,” she said with a laugh.